Those who invested in cryptocurrency early on have seen an impressive return on their investment. Just this month investors have seen the value of bitcoin exceed $38,195 US. According to buybitcoinworldwide.com, the first recorded exchange of bitcoin for currency took place in 2009 and resulted in 5050 BTC being traded for $5.02 through Paypal. The difference in value between that transaction and current transactions is an increase of almost 661 percent in just 12 years! With that increase though, comes a tax liability that many investors may not completely understand. Developing a smart tax-planning strategy is vital protection for Bitcoin, and other cryptocurrency, investors.
THIS INFORMATION IS FOR INFORMATIONAL PURPOSES ONLY AND IS NOT TO BE CONSIDERED AS LEGAL ADVICE.
What Is Bitcoin?
As defined on the website, bitcoin.com, “Practically speaking, Bitcoin is a form of digital money that (1) exists independently of any government, state, or financial institution, (2) can be transferred globally without the need for a centralized intermediary, and (3) has a known monetary policy that arguably cannot be altered.”
The website further explains that Bitcoin is now traded globally with tens of billions of dollars in volume, and is usually regulated as a commodity or a currency. Since 2014, the Internal Revenue Service has considered cryptocurrency to be property – taxable property.
Taxation of Cryptocurrency
The taxation of cryptocurrency is complicated and complex. Because of this, it is especially important to consult with a tax specialist, like those at Melanin Tax Solutions. These specialists can help you better understand and follow current tax rules. In addition, with careful planning, they can help you minimize the amount of taxes you are required to pay.
Even if your cryptocurrency exchange sends you a Form 1099 for reporting your income from cryptocurrency transactions, that may not be enough to provide all of the information required by the IRS for your tax return. To correctly calculate your capital gains for tax filing, you need to know when you bought the cryptocurrency and how much you paid for it. You must also know when you sold it and for what price.
So again, taxation of cryptocurrency is complicated and if you don’t have a tax-planning strategy early on, you could be losing substantial amounts of your gains to paying taxes. And, if you haven’t been filing and paying taxes properly – or at all – on your cryptocurrency assets, you could end up paying penalties too.
Strategies
There are several different tax-planning strategies currently available to cryptocurrency investors. And again, a tax specialist will be able to help you understand these strategies and determine which one, or ones, would best fit your particular needs. The following are just a few of those strategies to consider and will be summarized in very general terms.
1. Controlling Your Tax Bracket Status
This strategy involves very detailed bookkeeping and at least a working knowledge of tax bracket cutoffs. Tracking all sources of income, including cryptocurrency, as well as all applicable deductions is essential. As the investor edges closer to a higher tax bracket they can begin to identify and sell off high-basis cryptocurrency that they have held for longer than a year. By carefully managing how much is sold, they can not only maintain their status in a lower tax bracket but also minimize capital gains taxes.
2. Charitable Remainder Trust
Key factors to remember with this strategy are:
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The trust must be for a qualified charity
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The donor receives a lifetime income of not less than 5 percent (5%) of the initial value of the amount transferred into the trust.
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The charity does not actually receive the trust until the death of the donor, but the donor gets a tax deduction just as soon as the trust is set up.
3. Qualified Opportunity Fund
This particular tax-planning strategy applies more to very advanced and successful investors with large investment portfolios. This class of investors would be those who have experienced very large returns on their initial investment, for the purposes of this discussion, their investment in cryptocurrency.
As explained on time.com, quality opportunity funds were created from the Tax Cuts and Jobs Act in 2017, and were designed for investors to use their capital gains to invest in “opportunity zones.” These zones are designated geographical zones that are economically distressed, and there are very specific stipulations on how those investments can be used. But basically, investors in these funds are required to make “substantial improvements” to these areas equal to or greater than the value of their initial investment. Again, this is a strategy for very large investments.
4. 401(k)s & IRAs
More traditional tax-planning strategies for the average Bitcoin investor include 401(k)s and both traditional and Roth IRAs. These are all viable investment vehicles for Bitcoin investors. Since the IRS classifies cryptocurrency as property, many existing rules for these options apply to cryptocurrency deposits as well. Just make sure you understand all associated rules, limits, and potential penalties for early withdrawals and other
Summary
Tax-planning strategies are essential for any investor. Consulting with a tax specialist like those at Melanin Tax Solutions is an important step in understanding which strategies are most advantageous for your particular situation. Tax rules and exceptions for investment in Bitcoin and other cryptocurrencies are fairly new and complex, so this consultation is especially important.
A few examples of tax planning for Bitcoin investors to explore with a tax specialist include controlling your tax bracket, setting up a charitable remainder trust, contributing to 401(k)s, or traditional or Roth IRA’s. For particularly affluent investors, there is also the option of investing in a qualified opportunity fund.
If you are a Bitcoin investor looking for assistance in navigating your tax-planning strategy options, contact Melanin Tax Solutions today for a consultation.